BLOG: The key market movers UK and European investors need to watch

As Brexit talks continue amid a benign inflationary environment, here are four points investors in the UK and EU need to watch.

1) The future is brighter for the UK economy but the uncertainties of Brexit linger

It goes without saying that Brexit has been at the forefront of many investors’ and business’ minds. Prime Minister Theresa May’s speech in February on the future relationship could offer insights into the UK’s position on a number of issues. Any further details on trade between the UK and EU as well as services industries will be important for markets.

Business investment has slowed since the Brexit vote, as many are delaying major economic decisions until they have more clarity about what life outside of the European Union will look like. If the UK manages to agree a favourable transition deal, businesses may refocus their efforts more fully back onto their day-to-day business rather than what happens when the UK leaves the EU in 2019.

But the future does look brighter. While there may be potential for further slowdown in investment, overall the UK economy should remain fairly solid. Sterling is up significantly against the US dollar, relative to where it was in 2016, which could help inflation ease over time, and potentially slightly better wage growth. There could also be the possibility of improved productivity growth if businesses invest more.

In the meantime, investors in UK assets will have to grapple with fluctuations in the sterling exchange rate as well as varying domestic macro fundamentals. Large-cap FTSE 100 companies receive around 70% of revenues from overseas, whereas the mid-cap FTSE 250 has a larger exposure to the domestic UK economy. Therefore, a fall in the pound would favour internationally exposed large-cap stocks, whereas a rise in the pound should favour smaller, more domestically-focused stocks. Given the uncertainties and many moving parts of the Brexit talks, not taking large size or sector bets seems appropriate at this point.

2) All eyes on the Italian elections – 4 March

A new election system and several anti-establishment parties means the process and results could somewhat rattle markets. A government with populist parties promoting a re-evaluation of Italy’s involvement with the EU would be a concern given the unprecedented nature of the proposition.

However, we perceive the risk of an anti-euro election result possible, but not the most likely scenario given the recent polling data for Five Star Movement and Lega Nord. What’s more, in recent months Italian growth has shown signs of recovery and falling unemployment has been a great antidote for populism. In fact more Italians support the euro now than over the past several years. Despite the lower probability of a market-rattling event, the size of the Italian bond market (the largest in the Eurozone) and the tendency for markets to reflect risks in the price of the euro exchange rate make the Italian election worth keeping an eye on.

3) European Central Bank – the most exciting central Bank to watch this year

Most importantly, all eyes will be on the rhetoric of the European Central Bank at its meeting on 8 March. While the ECB may be tapering its Quantitative Easing programme, it is still purchasing EUR 30bn worth of bonds on a monthly basis. Stronger growth in the region may push the ECB to consider reducing asset purchases to zero, however stubbornly low inflation in the region would be a reason for the bank to keep interest rates low. At this point rates are not expected to increase in Europe until a period of time after QE has ended.

If the ECB and Bank of Japan (BoJ) were to get more bullish this year we may see longer-term rates rise more which might limit the ambitions of the Fed. But given we think both the ECB and BoJ will continue to be plagued by low inflation that will in turn give the Fed scope to tighten by at least a further 0.75% (three rate increases) this year.

4) Picture remains solid for the European earnings.

European earnings grew strongly last year, helped by an acceleration in nominal GDP. The International Monetary Fund (IMF) forecasts that nominal eurozone GDP growth will be a little weaker this year, at 3.3%. Slightly weaker Eurozone growth should lead to lower, but still reasonably strong positive earnings growth for eurozone companies. The historical relationship between nominal GDP growth and European EPS implies earnings growth of around 10%, which should be supportive of Eurozone equities. Recent survey data from the eurozone, such as the strongest manufacturing PMI on record, suggests that nominal GDP growth may outperform expectations. If growth is stronger than expected, consensus expectations for earnings growth could be surpassed. A stronger growth environment and a steepening European yield curve mean cyclical stocks and financials remain attractive.

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